Cotton Futures – An Impact Assessment Study
Dr. V. Shunmugam Head - Research, Multi Commodity Exchange of India Ltd (MCX)
Uncertainty and volatility in cotton prices remain at elevated levels. Annualised volatility of cotton prices were as high as 18.3% and 21.3% in 2016 and 2017, respectively. A part of the reason for such high volatility is the international nature of this agri-commodity, whose 32 per cent of world production enters international trade every year. This means that the fundamental factors in multiple countries, not to mention the dynamics of international trade, go on to determine the prices of cotton in India (as elsewhere). In fact, four countries –
India, China, United States and Pakistan – account for about 70 per cent of the world production, which indicates the extent to which factors originating in multiple countries affect cotton prices, or make them volatile.
When the heightened volatility in cotton prices is passed on to the value chain of the commodity – a complex maze running from the farmer to the ultimate consumer, undergoing several layers of processing and value addition – the effect is heightened volatility in the prices at each node of the value chain, giving rise to inflationary tendencies.
COTTON DERIVATIVES AS A HEDGING TOOL
In order to cope up with this problem, market-based risk management tools have assumed significance in recent times. Commodity derivatives markets serve as an important platform for bringing stability in the commodity markets by providing stakeholders with the avenue for risk management. In the context of the cotton market, the exchange-traded cotton futures contract has been beneficial for all sections of the economy, including farmers and consumers; it provides advanced price signals to sellers (farmers/producers) and assists buyers (consumers) of agricultural commodities to decide on the time for purchase of the commodity, giving a tool for hedging the uncertainty in prices across time periods.
Against this backdrop, a study# on the impact of cotton futures was undertaken by the Icar-national Institute of Agricultural Economics and Policy Research, New Delhi (NIAP). The study, inter alia, investigated improvements, if any, that cotton futures might have brought on the stakeholders of various elements in the commodity’s value chain. It also examined the indirect impact of availability of futures prices to the farmers and traders’ ecosystem through availability of knowledge about prices, price realization by producers and price linkages among the major domestic markets and with the futures market.
FINDINGS OF THE STUDY
The main findings of the study are summarised below.
Integration of physical and futures prices : Price movements in futures markets were analysed with those in ten selected cotton markets from five major cotton producing states of India – M.P., Gujarat, Haryana, Telengana and Rajasthan. The study found a great degree of integration among the markets and with the futures market, with high, positive and statistically significant coefficients of correlation among them. This indicates that, leaving aside the logistic cost of storage and transportation, cotton prices across markets move together and are in tandem with the futures prices. Higher integration of cotton prices among the markets also implies more competition among the markets and hence farmers may expect more competitive prices for their produce. Since the signs of all the coefficients are positive, prices were found to move in similar direction.
Price discovery : The study revealed that cotton futures has greatly helped the growers with regard to providing some kind of referral or indicative price at a reference point to start negotiation with the buyer. Thus, even if the growers were not trading on the exchange platform, they could derive a lot of benefit simply by knowing the exchange-traded prices, and use that as a reference for their negotiations. For instance, when enquired about the overall changes in the cotton industry after introduction of cotton
Cotton futures have had perceptible impact on the cotton ecosystem and various stakeholders, but much more remains to be achieved through widespread dissemination of exchange-traded prices, warehouse receipt finance and propagating the benefits of improved efficiency, transparency and liquidity.